Taxation Issues. The Rioja Company (Rioja). Spanish-based manufacturer (Case Study Sample)
The Rioja Company (Rioja), a Spanish-based manufacturer of pleasure sailing boats, purchased a fiberglass molding machine on January 1, Year 1 for euro 100,000. The use life of the molding machine for book purposes is 10 years on a straight-line basis with no salvage value. The Spanish tax authorities allow for depreciation for this type of machine over 5 years on a straight-line basis. The corporate tax rate in Spain is 35%. The book basis, the tax basis, and the balance in the deferred tax liability account for this machine for the first 5 years were as follows, respectively:
Book cost: euro 100,000 each year
Book Accumulated Depreciation: euro 10,000 at the end of Year 1, increasing by euro 10,000 each year for Years 2-5
Book basis: Book cost less book accumulated depreciation, respectively, for each year using the above information for Years 1-5
Tax Cost: euro 100,000 each year
Tax Accumulated Depreciation: euro 20,000 at the end of Year 1, increasing by euro 20,000 each year for Years 2-5
Tax basis: Tax cost less tax accumulated depreciation
Deferred tax liability: euro 3,500 at end of Year 1; increasing by euro 3,500 each year from Years 2-5
On December 31, Year 3, after recording its year-end journal entries, Rioja receives an offer to sell the molding machine to an Italian-based sailboat Company, Vino, for euro 120,000. Rioja has a very short window to consider what its options are for this machine, as Vino would like to complete the transaction on January 1, Year 4.
Prepare a document, including any required supporting schedules and each required journal entry, to help explain the income tax ramifications for Rioja’s options under both the US GAAP and IFRS. Each journal entry should be accompanied by an explanation of how you calculated the dollar amount of the respective journal entry and be supported by reference(s) to the respective IFRS and FASB literature.
Once your analysis is complete, what will you recommend to management of Rioja? Should it accept Vino’s offer or not, and why or why not? Make your recommendation specific.
Your Word document submission should be 3-4 pages in length (not including the required cover and references pages). Submissions in excess of 4 pages are permissible.
Format your submission according to the CSU-Global Guide to Writing & APA.
Be sure to discuss and reference concepts taken from the required and recommended readings and your own relevant research.
You must include a minimum of three credible, academic, or professional references beyond the text or other course materials.
Prepare a document, including any required supporting schedules and each required journal entry, to help explain the income tax ramifications for Rioja’s options under both the US GAAP and IFRS.
The Depreciation on deduction on tax return was $20,000 in the tax basis and for the five years the tax depreciation deduction totals of $100, 000 in the five years. On the other hand, the depreciation expense on the book basis is 10,000 as the asset has a useful life of 10 years. Weil, Schipper & Francis (2014), pointed out than both the “U.S. GAAP and IFRS require firms to calculate income tax expense based on pretax book income. Thus, when pretax book income remains the same”. At the same time, the IFRS does not recognize the valuation allowance when dealing with the deferred tax assets unlike the US GAAP, where the assets are reduced by the valuation allowance. The management of Rioja ought to accept Vino’s offer since there will be no deferral lax liabilities and the company will sell the molding machine and make a gain on the asset disposal.
As the tax depreciation was $20,000 and the book depreciation $10,000, the income tax payable was lower at $28,000 compared to the income tax expense of $31,500. As such, the deferred tax in years 1- 5 is $ 3,500 (31,500-28,000) if the asset is not sold. Other than the straight-line depreciation method, the US allows the Modified Accelerated Cost Recovery System (MACRS) system for the income tax system, but the straight line methods the most common outside the US (Krumwiede & Farrar, 2016). The deferred tax liability (DTL) increases by $ 3,500 in the five years where in the fifth year the total would be $17,500 if there is no sale.
The book basis, the tax basis, and the balance in the deferred tax liability account. To determine the temporal difference balance and deferred amount, it is necessary to first determine the book value of the asset or liability to be considered. The book value depends on the financial statements and the second consideration is the asset or liability tax base (Choudhary, Koester & Shevlin, 2016). The tax basis is what is reported in the tax returns. When the tax base is greater than the book value, then one deducts the temporary difference for the deferred asset like a deductible asset, and vice versa where the deductible amount for deductible amount for the depreciation. There are proposals to converge the US GAAP and IFRS on recognizing the deferred tax liabilities and assets as current and non urgent items. This is reflected in Accounting Standards Codification (ASC) 740, Income Taxes, where the position classification highlights the need for guidance to reduce differences between the US GAAP and IFRS, and proposals have been accepted targeting the public entities (Choudhary, Koester & Shevlin, 2016).
The income tax expense for the year includes the current and deferred income tax, which is recognized in the income statement. The current tax liability in each of the five years is $ 28,000 and if Rioja sells the machine there will be reduce taxed liabilities. Deferred income tax focuses on the liability method on temporary differences between the tax bases of assets and liabilities and their respective values in the financial statements. The income tax expense for the period includes the current income tax and deferred. The tax is recognized in the income statement, except when dealing with items that they are recognized in other comprehensive income or equity. While the current income tax is calculated based on the tax laws, the management will still need to evaluate the tax position and establish the relevant provisions.
YOU MAY ALSO LIKE
- Accounting for Income Taxes at Apple, Inc. Case StudyDescription: Questions related to permanently reinvested earnings (PREs)1. How much cash, cash equivalents, and marketable securities did Apple shareholders really own, net of the IRS claims on this cash? ...8 pages/≈2200 words | 6 Sources | APA | Accounting, Finance, SPSS | Case Study |
- MW Petroleum Corporation Case WriteupDescription: There are differences in the way Amoco the parent company of MW Petroleum and Apache (buyer) value the deal to buy the former, since Amoco is more optimistic that oil prices will improve, but Apache seeks to reduce costs....3 pages/≈825 words | 2 Sources | APA | Accounting, Finance, SPSS | Case Study |
- AMR - American Airlines Case Study ReportDescription: The paper will focus on the valuation of bonds, which are debt instruments, highlighting how the time to maturity at 10 years, 20 years and 30 years and interest rate at 8% and 12% affect the bond prices....2 pages/≈550 words | 3 Sources | APA | Accounting, Finance, SPSS | Case Study |